Get ready for the end of Fed independence

Markets haven't yet grappled with implications of president having control over central bank

- Greg Ip

The market response to President Trump's Monday attempt to fire a Federal Reserve governor was relatively subdued. Don't let that fool you. If Trump's effort to remove Lisa Cook for cause succeeds, and perhaps even if it doesn't, this week will go down as one of the most consequential for financial markets in decades.

It could mark the end of the Federal Reserve's independence from White House control, which it effectively obtained in 1951. As a result, inflation is likely to be higher and more volatile than in the decades before 2020.

Investors aren't yet pricing in such a scenario. In part that's because the Fed was already preparing to cut rates. On Friday, Chair Jerome Powell indicated that tariffs were unlikely to lead to sustained inflation given a weak labor market, opening the door to a rate cut in September. In the near term, that should boost stock prices and bring down bond yields.

More important, investors have no historical template for a politicized Fed and assume its leaders under Trump will behave as they have under previous presidents, setting interest rates according to the economic data and their forecast.

Investors would be wiser to assume that starting sometime in the next nine months, the Fed will set rates according to Trump's preferences.

This is the logical conclusion based on the lengths Trump has now shown he will go to gain control of the Fed. In the central bank's 11-year history, no president has tried to remove a governor. As investment bank Evercore ISI said in a note to clients Tuesday: "Asset markets are not properly priced for what increasingly seems likely to be a rupture in Fed independence."